The sloppy trail of an alleged insider trader

(poetsandquants.com) — On Nov. 19, Samir Barai went online to the website of The Wall Street Journal to read a story that had to set off all kinds of alarm bells. The headline on his computer screen: “U.S. in Vast Insider Trading Probe.”

Barai, 39, founder of a New York-based hedge fund firm called Barai Capital Management LP, could scarcely believe what he was reading.

“Federal authorities, capping a three-year investigation, are preparing insider trading charges that could ensnare consultants, investment bankers, hedge-fund and mutual-fund traders, and analysts across the nation, according to people familiar with the matter.”

As Barai kept scrolling down the screen, the story’s details could only have made his stomach churn. “The criminal and civil probes, which authorities say could eclipse the impact on the financial industry of any previous such investigation, are examining whether multiple insider-trading rings reaped illegal profits totaling tens of millions of dollars, the people say. Some charges could be brought before year-end, they say.”

Barai’s attention, however, would have been especially drawn to the story’s fifth paragraph. It noted that the Feds were examining a Silicon Valley “investment research” firm called Primary Global Research LLC that connected experts with investors seeking information in the technology and health care fields. Barai allegedly knew Primary Global well — he had been paying an employee in the firm for inside information for years, according to federal investigators.

Later that day, tapping out a text message on his Blackberry, Barai admitted to a colleague at his firm that he had read the Journal story 10 times. The Harvard MBA had good reason to panic, according to allegations filed by the government. For the past four years at least, he had been using inside information to trade public securities of a number of technology companies. In some cases, he allegedly got advance notice of revenues, profits and gross margins before public announcements, all from paid informants inside the companies. In other cases, he allegedly got the inside dope from Winifred Jiau, a contact at Primary Global in Mountain View, California.

That day, Nov. 19, 2010, it was hard for Barai to put the Journal story out of his mind. Later that evening, during a lengthy exchange of messages sent from his Blackberry, he told Jason Pflaum, a 38-year-old research analyst at his firm, that he had also read a follow-up article by Reuters.

As Barai summarized the contents of the WSJ and Reuter stories to Pflaum, according to investigators, Pflaum played dumb, allowing his boss to relay the highlights as if he had no knowledge of what was going on. What Barai didn’t yet know was that Pflaum, who began working for Barai Capital in March 2008 as a research analyst, had already agreed to cooperate with federal investigators in exchange for a reduced sentence.

“Fuuuuuck,” concluded Barai. “Delete ur bbm chart,” he finally wrote before signing off for the night and trying to go to sleep at his one-bedroom, high-rise apartment in lower Manhattan.

Early in the morning on Tuesday, Feb. 8, Barai surrendered to federal investigators in New York and was charged with securities fraud, conspiracy and obstruction of justice. Barai, who would not comment for this story, is accused of engaging in insider trading involving shares of Marvell Technology Group Ltd. (MRVL), Fairchild Semiconductor International Inc. (fcs) and several other tech firms.

Friends of Barai, meantime, are dumbfounded that he has gotten himself ensnared in one of the largest insider trading investigations ever. They note that he had overcome many obstacles that led to the creation of his hedge fund firm, which manages about $100 million in assets.

He was known to be an incredibly hard working, self-made person, the American born son of a computer retail store owner in New Jersey. In high school, guidance counselors told him his best chance of advanced study was to go to a community college. Instead, Barai managed to get into New York University, where he sat in the front row of classes and read the lips of professors.

He landed a job with Merrill Lynch, before going to Harvard Business School where he earned his MBA in 1999. Friends say Barai, who call him “Sam,” is a self-effacing and humble person, gentle and generous.

“He is one of the nicest, most giving individuals I’ve ever known,” says one friend. “It makes you wonder how after all this hard work he’d wind up at this point.”

Back at his alma mater, where a new Harvard Business School dean is emphasizing values and ethics, there is deep disappointment.

“These are serious allegations, which if proved true are of great concern to me as a teacher, as a dean, and as someone who is dedicated to restoring people’s trust in business leaders,” said Dean Nitin Nohria in a statement. “We try to do all we can at HBS to convey the importance of integrity and accountability to our students and will keep striving to do more.”

Indeed, during his first year at Harvard, Barai would have taken the required course ”Decision Making and Ethical Values,” that had been put into HBS’ curriculum eight years earlier. The module offered students an ethical framework to use as a guide in making decisions and using sound judgment.

The lessons from that class, including several case studies on ethics, must have eluded him. And now Barai could very well become the protagonist in a Harvard Business School case study himself. The government’s complaint, including an affidavit from an FBI agent involved in the investigation, has all the detail to make a riveting case study for future MBA students.

The day after Barai read the Journal story online, it appeared in print in the newspaper’s Nov. 20 edition. Both Barai and Pflaum apparently spent a restless night, worried about how the case would unravel.

Pflaum sent his boss a message early that morning. (Their detailed text messages, including typos and short cuts, are contained in the government complaint.)

“Yo,” Pflaum wrote, “deleted them. Didn’t sleep so well last night.”

“Didn’t sleep much either,” shot back Barai.

“What do you think we need to do?” asked Pflaum.

“I dunno,” Barai answered. “I think we ok tho. I think U just go into office. Shred as much as u can. Put all ur data files onto an encrypted drive. I think all your offline stuff is an issue.”

Barai, apparently thinking that he could beat the Feds to any possible evidence against him, then told Pflaum to delete all the emails from contacts at Primary Global.

“I deleted mine,” he said.

The back-and-forth text messages seem to belie whatever anxiety Barai had to be feeling at the time. After telling his associate to shred documents and delete emails, Barai then seemed to put on a good show that the investigators would never get either of them.

“So what if we talked to anyone,” Barai said, referring to another hedge fund manager also implicated in the insider trading scandal.

“They need proof that we acted on something and it’s hard to have that. My sense is they tapped the firm just recently. The more I think about it — just not enough clues to hold something on us. There isn’t anything tho. Nothing material. We use all mosaic theory so we’re ok.”

Mosaic theory allows an analyst to place a value on a security using an array of sources, both public and nonpublic. Barai seemed to be trying to reassure himself and his associate that they would be able to get away with it.

“Let’s not worry. Forget the past. No proof. So ur fine. BTW — we did mosaic theory,” he repeated into his Blackberry. “We always do.”

As it turned out, Barai had plenty to worry about — especially because he had put complete trust in Pflaum, who had been cooperating with investigators. Pflaum was one of Barai’s earliest employees, coming aboard less than three months after Barai launched his hedge fund in a midtown Manhattan office near Citigroup’s (c) headquarters.

Not much more than two months after joining Barai Capital, Pflaum participated in a telephone conference call on May 23, 2008, to discuss an upcoming quarterly earnings announcement from semiconductor maker Marvell Technology. Marvell was scheduled to report the numbers six days later. Barai had asked Pflaum to listen in and take notes on the call, presumably because of Barai’s hearing problems.

Winifred Jiau allegedly gave Barai inside information to trade on.

At 2:17 p.m. on May 23, Barai called Jiau, his contact at Primary Global, in California. Jiau, an American-born Taiwanese with a master’s in statistics from Stanford University.

In a phone call lasting some 43 minutes, Jiau said that Marvell’s revenues for the quarter would come in at $805 million and that the company’s gross margin would be about 53%. Pflaum dutifully took notes on the conversation. That same day, according to the government, Barai bought more than 300,000 shares of Marvell for some $4.4 million.

Just five days later, on May 28 — the day before Marvell would make its numbers public — Barai placed yet another phone call to Jiau at 11:19 a.m. During the 20-minute conversation, Jiau was even more specific: she said Marvell would report quarterly revenues of $804 million, gross margins of 51.6%, and earnings of 11 cents per share. That day, Barai bought another 100,000 shares of the company’s stock.

The next day, May 29, Marvell reported its results and they were exactly what Jiau told Barai they would be. The stock jumped 23%. Ultimately, investigators allege, Barai made $820,000 in net earnings by trading on this information alone.

Over the course of the more than two years that Pflaum worked with Barai there would be many more trades and similar conversations with Jiau but also employees of companies in Silicon Valley who were leaking information to Barai and others, according to the government. Pflaum would later tell the FBI that he “followed Barai’s instructions” and obtained inside information at many technology companies, including Advanced Micro Devices (amd), Fairchild, Actel, and Cypress Semiconductor (cy).

It is not known when or why Barai first allegedly began using inside information to makes trades. Barai did not respond to several inquiries requesting comment. But according to the government’s unsealed complaint, he started as early as 2006 when he worked for Citigroup’s Tribeca Global Management as managing director.

In any case, two days after the Journal’s story appeared on the web, Barai was again communicating with his friend and colleague Pflaum. On Nov. 21, Barai asked Pflaum to leave his laptop computer with the doorman at Pfaum’s apartment building so that he could pick it up.

Barai said, according to the government’s complaint, that he could “encrypt it and do a dept. of defense delete” so the deletions could not be restored. It was the same laptop Pflaum used to record notes of the conversation with Jiau and others.

During the text exchange, Pflaum told Barai he was at the office “taking care of stuff. Let me know if there is anything else you think I shud do.”